Reasonable Basis, Customer Specific and Quantitative Suitability Guidelines

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FINRA Reasonable Basis, Customer Specific and Quantitative Suitability Guidelines:

The Financial Industry Regulatory Authority ("FINRA") is an independent, not-for-profit organization authorized by Congress to protect America's investors by making sure the securities industry operates fairly and honestly. This is accomplished, in part, by writing and enforcing rules governing the activities of more than 4,140 securities firms with approximately 633,155 brokers. As we have continuously pointed out on our website and blog, the securities business is highly regulated. One of the core issues of regulation, for the individual investor, relates to the issue of suitability.

FINRA has adopted a "Suitability" Rule which can be found in the FINRA Rule Book in Rule 2111. The components of suitability obligations set forth in Rule 2111 are composed of three main obligations: reasonable-basis suitability, customer-specific suitability, and quantitative suitability.

(a) The reasonable-basis obligation requires a member or associated person to have a reasonable basis to believe, based on reasonable diligence, that the recommendation is suitable for at least some investors. In general, what constitutes reasonable diligence will vary depending on, among other things, the complexity of and risks associated with the security or investment strategy and the member's or associated person's familiarity with the security or investment strategy. A member's or associated person's reasonable diligence must provide the member or associated person with an understanding of the potential risks and rewards associated with the recommended security or strategy. The lack of such an understanding when recommending a security or strategy violates the suitability rule.

(b) The customer-specific obligation requires that a member or associated person have a reasonable basis to believe that the recommendation is suitable for a particular customer based on that customer's investment profile, as delineated in Rule 2111(a).

(c) Quantitative suitability requires a member or associated person who has actual or de facto control over a customer account to have a reasonable basis for believing that a series of recommended transactions, even if suitable when viewed in isolation, are not excessive and unsuitable for the customer when taken together in light of the customer's investment profile, as delineated in Rule 2111(a). No single test defines excessive activity, but factors such as the turnover rate, the cost-equity ratio, and the use of in-and-out trading in a customer's account may provide a basis for a finding that a member or associated person has violated the quantitative suitability obligation.

One of the most common claims made by a customer against a brokerage firm and/or account executive is that a particular investment or investment strategy is unsuitable for the client. While this concept is rudimentary, many issues relating to the theory of suitability are not that easy to discern. It is for that reason that you should only deal with an experienced FINRA arbitration and securities litigation attorney.

Please keep in mind that the above information is being provided for educational purposes only. It is not designed to be complete in all material respects. Thus, it should not be relied upon as legal or investment advice. If you have any questions, you should consult a qualified professional.

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